Year-End Window Dressing
Many stocks that have done well for the first 50 weeks of the year frequently trade even higher during the final 1-2 weeks of the year (e.g., Video Display +38% and another 4% during the 51st week of the year). Conversely, bad losers for year-to-date can take a final beating as the calendar year comes to a close (e.g., Salesforce.com -19% for the first 50 weeks and another 8% during the 51st week).
Performance bonuses means there is a strong incentive for hedge fund managers to load up on these winners and dump the losers. Mutual funds and hedge funds disclose their holdings as of December 31. Whatever the manager sells before 4 p.m. on the year’s final trading day will be omitting from the report. Funds that report holding big winning stocks attract positive attention and new cash from investors.
In some instances, fund managers may be “portfolio pumping” (entering very high bids for a few shares of stock they already own during the final few minutes of the trading day), which can result in existing fund holdings of thinly-traded stocks, artificially amplifying the value of the stock. As a result of this “signal jamming,” the funds can attract much more money than their peers. Of course, any stock pumped up this way is likely to deflate on the first trading day of the next year.
According to research done by a Wharton School researcher, stocks widely held by hedge funds pop 0.4% higher than the overall market on the final trading day of the year—and then underperform the average by 0.2% on the first day of January.
In the case of mutual funds, these types of practices have pretty much disappeared completely ever since state regulators and the SEC cracked down on the practice in 2001 and 2008.